With a price-to-earnings (or "P/E") ratio of 11.2x M.D.C. Holdings, Inc. (NYSE:MDC) may be sending bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 17x and even P/E's higher than 33x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Recent times haven't been advantageous for M.D.C. Holdings as its earnings have been falling quicker than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.

View our latest analysis for M.D.C. Holdings

Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like M.D.C. Holdings' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 46%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 5.2% overall rise in EPS. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Turning to the outlook, the next year should generate growth of 4.2% as estimated by the five analysts watching the company. With the market predicted to deliver 10% growth , the company is positioned for a weaker earnings result.

In light of this, it's understandable that M.D.C. Holdings' P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of M.D.C. Holdings' analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

And what about other risks? Every company has them, and we've spotted 3 warning signs for M.D.C. Holdings you should know about.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.